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Guest Post by Anthony Rickey: Five Reasons Tesla May Want to Move to Texas

Last week, the Court of Chancery’s ruling in Tornetta v. Musk rescinded Elon Musk’s unprecedented $55.8 billion pay package.  Musk responded by tweeting that Tesla will hold a stockholder vote on reincorporating in Texas.  The Houston Chronicle offered five reasons Musk might want to do so, including “politics” and “simplicity.”  Professor Ann Lipton, on the other hand, argues that Musk wants the move “because he expects the judges will be biased in his favor.”  I don’t find these explanations satisfying.  If nothing else, Texas hasn’t appointed its new business court judges yet, and those judges will have two-year terms.  If anything, the risk is that the character of the court can change with an administration.

But Musk’s tweets have put a spotlight on jurisdictional competition and, in that spirit, I’d like to offer five alternate reasons that Musk might find that a Texas move benefits Tesla.  Fair warning:  this analysis stems less from my perspective as a Delaware lawyer than from my status as a Tesla stockholder.   I bought 50 shares—far more than the Tornetta plaintiff—in late 2022.  My holdings have almost doubled in value, making Tesla my most successful investment since my law degree.  Perhaps Tornetta will result in a more efficient, successful company and my investment will double again.  Then again, perhaps not.  With that in mind, here are five reasons Tesla might want to move to Texas.

1. Musk and Delaware Just Don’t Vibe.

Even before Tornetta, there was little doubt that Elon Musk places little value on procedural niceties.  Not his style.  His Boring Company made a flamethrower.  More seriously, he landed in hot water after tweeting about taking Tesla private.  It is hard to argue with Tornetta’s proposition that Musk “has no filter.”  But he’s also provided considerable stockholder value:  even the Tornetta opinion concedes that Musk’s tenure coincided with remarkable growth in Tesla’s stock price, which is what made him eligible for a $55.8 billion payout in the first place.  Process may not be a prerequisite to growth.

 But Musk’s temperament may be ill-suited to Delaware, which places greater value on process.  While nothing in Delaware statutory law bars Musk’s pay package, longstanding doctrine protects stockholders from “controlling shareholders” by subjecting conflicted transactions to entire fairness review, under which a company and its board must prove that a transaction is fair in price and process.  While it is possible for a defendant to meet that burden—indeed, Musk did so in the SolarCity case—it’s challenging.  To avoid this harsh burden, Delaware permits controlling stockholders to “cleanse” a conflicted transaction by seeking approval from both (a) a committee of independent directors and (b) fully-informed, disinterested stockholders.

After Tornetta, it is easy to see why Tesla (and Musk) may have difficulty meeting this burden, even outside the executive pay context.  While director and stockholder approval are technically different analyses, in practice they can collapse into one another.  Tornetta (a) finds that Tesla’s board was not independent of Musk, at least for this decision, and (b) holds that the vote was not fully informed because stockholders were told that the board was independent.  Failing the first hurdle may lead to failing the second.

Thus, Delaware law leaves Tesla in a conundrum.  Musk may be mercurial—but he’s led the business to profit.  Perhaps Tesla can appoint a few directors that the Court of Chancery might ultimately consider independent of Musk.  But perhaps not, or at least not without changing the corporate culture:  the Tornetta opinion condemns the Tesla board’s negotiation of Musk’s pay package for being a “cooperative and collaborative process.”  In a business context, cooperation and collaboration are generally considered positively, not negatively.  Tornetta essentially imposes a choice between (a) adversarial, non-cooperative salary negotiations with Musk or (b) perpetual lawsuits where Tesla must prove that its decisions are fair.  Tesla, and Musk, may desire other options, and Texas incorporation could provide an alternative.

2. One More Delaware Lawsuit.

Tornetta leaves Tesla with another problem:  even if it reformed its governance, it’s a large, successful company that’s an attractive target for plaintiffs’ lawyers.  In the best of scenarios, it’s likely to get sued.  And reality isn’t the best of scenarios:  as Professor Lipton noted on Bluesky, a California lawsuit alleging that Tesla mishandled toxic waste will likely lead to a books-and-records and then a derivative suit against the Tesla board.  The question isn’t whether Tesla will be sued in Delaware again, but how many times.

Reincorporation in Texas reduces that number to, potentially, one.   Another Delaware plaintiff is currently suing to prevent TripAdvisor from reincorporating in Nevada.  The Court of Chancery’s decision is pending.  Barring total victory for TripAdvisor, however, the odds that Tesla can reincorporate in Texas without first facing expedited litigation in Delaware seem slim.

In that sense, Tornetta presents a challenge to states like Nevada and Texas that have created business courts to compete with Delaware.  If Delaware plaintiffs can make it more difficult for corporations to leave the First State, can competitors adopt legal provisions making it easier, or allowing corporations to recover after reincorporation from shareholders who frustrated an attempted exit?  I don’t know—but given that Governor Abbott explicitly encouraged Tesla’s move, it would not be surprising if some legislative aid has been diligently researching possible reforms over the last week.

3. Stockholders Might Recover More in Texas.

Meanwhile, stockholders may be better off litigating against Tesla in Texas.  A Texas business court might not have decided Tornetta any differently.  As Professor Ben Edwards notes, “The last thing Texas is going to want is a reputation that their corporate law is a game where billionaires always win, because then investors aren’t going to trust it.”  Unlike Nevada (where X/Twitter is now incorporated), Texas has not statutorily abolished entire fairness review.  It remains to be seen whether the Lone Star state will be any less plaintiff-friendly than Delaware.

However, Texan tort reform may benefit post-reincorporation Tesla stockholders by allowing them to keep a greater percentage of recovery from a successful lawsuit.  In class actions, Texas limits attorneys’ fees to 400% of the plaintiffs’ attorneys’ lodestar.  If the recovery is in “noncash common benefits,” then attorneys fees must also be noncash.  Texas has yet to apply this rule to derivative lawsuits like Tornetta, but that is a potential next step for the business court. 

Were the Tornetta plaintiffs to receive fees in this fashion, each attorney would still make thousands of dollars per hour—but even at 400% of lodestar, the fee probably wouldn’t reach $1 billion.  And Tornetta did not result in a cash judgment but the rescission of Musk’s unexercised stock options.  It seems odd, but a Texas court could potentially compensate a Tornetta-style plaintiff by awarding their counsel an interest in Musk’s options—which the attorneys would have to pay to exercise and perhaps, like Musk, hold for a period of time.  That might not be bad:  the attorneys would immediately become some of Tesla’s largest stockholders, but they would also have skin in the game.  A cash award offers attorneys no reason to care whether Tornetta benefits or harms Tesla in the long term.  (And stockholders who, like Tornetta, own nine shares have little interest altogether.)

Delaware is very different:  rather than using lodestar, Delaware bases fee awards on a percentage of any benefit secured in litigation.  And a recent Delaware decision, In re Dell Technologies Inc. Class V. Stockholders Litigation, held that the percentage awarded does not decline in mega-settlements.  (Full disclosure:  I represent some law professors pro bono as amici curiae in Dell, which is on appeal.)  Instead, Delaware plaintiffs’ attorneys typically receive somewhere between 10-15% of a class recovery in cases that settle early, 15-25% that settle after some motion practice and depositions, and up to 33% after trial (as in Tornetta).  The Court of Chancery has yet to award fees to the Tornetta attorneys, and the award will be complicated by the need to determine how much Musk’s shares are worth to Tesla.  (A similar issue has arisen in a dispute over pay to Tesla’s other directors.) But lawyers are already speculating that the award may exceed $1 billion.

Tornetta highlights two paradoxes in Delaware mega-cases.  First, even when plaintiffs win big, stockholders might be better off with smaller victories if their attorneys were limited to, say, a mere $5,000 per hour in fees.  Second, Dell and Tornetta set different standards for directors and attorneys.  Plaintiffs’ lawyers in the Court of Chancery receive an ever-greater percentage of stockholder gains based on a set of milestone payments.  One doesn’t have to squint hard at Musk’s pay package to recognize that it is also an escalating percentage award based on milestone payments—although the percentage increases more slowly than the brackets in Dell.  Yet Tornetta repeatedly faults Tesla’s directors for not considering whether Musk warranted any incentive pay beyond the 21.9% of Tesla he already owned.  Corporate directors might reasonably ask why CEOs require less incentive to produce stockholder value than the attorneys who sue them.

4. Tesla May Have an Easier Time Renewing Musk’s Pay Package.

In 2006, Professors Lucian Bebchuck and Jesse Fried published Pay Without Performance:  The Unfulfilled Promise of Executive Compensation.  Tornetta results in the opposite:  performance without pay.  Back in 2018, the New York Times Dealbook recognized the challenge for Tesla to reach $650 billion in market capitalization:  “many experts would contend [it] is laughably impossible.”  Dealbook offered that critics would say Musk’s pay deal was “the company’s latest publicity stunt.”   Reaching a laughably impossible goal certainly seems to qualify as CEO performance in the Bebchuck/Fried sense.

Yet unless Tesla reinstates some form of pay package, Musk receives nothing for this achievement apart from his existing holdings.  Thus, commentators have spent much of the last week speculating over whether, and how, Tesla might compensate Musk for past services.

Professor Lipton argues that awarding Musk “compensation for services provided would likely be waste. . . .”  I don’t think that’s right, for two reasons.  First, the Court of Chancery has dismissed waste claims challenging one-off payments for past services rendered, albeit typically in the context of a severance or retirement arrangement.  I’m only aware of one case where a waste claim concerning executive compensation withstood a motion to dismiss, and there a company agreed to a continuing salary payment in exchange for services that it allegedly knew the executive could not render due to age and disability.  That’s certainly not the case here.  Second, the standard for waste is severe.  A corporation must enter into a transaction “so inadequate in value that no person of ordinary, sound business judgment would deem it worth that which the corporation has paid.”  A cursory glance at the internet—where Tesla stockholders are debating the decision—shows that at least some stockholders believe Musk’s compensation was fair and want it reinstated.  A plaintiff would need to argue that these stockholders are, essentially, not in their right mind.  Even Tornetta does not go that far.

But another lawsuit for breach of fiduciary duty would be likely.  Suppose Tesla comes up with an alternate pay package.  Even if Tesla nominates some new directors, it can’t know that the Court of Chancery will ultimately find them to be independent.  It certainly can’t have a “cooperative and collaborative process.”  And even if Tesla offers ridiculously thorough disclosure—perhaps it livestreams the relevant board meeting?—it can’t ensure that the Court will find its vote fully informed.  Without both conditions, it will just get sued again, with (at best) the plaintiff bearing the burden of proving the deal unfair.  As Matt Levine puts it:

It is possible that the rule of this case is that Tesla is not allowed to pay Musk $55.8 billion, no matter what its shareholders think, no matter how many of them vote to approve it in a fully informed vote. It’s enough to make you want to move to Texas.

Tesla may find it easier to reinstate Musk’s pay package—or adopt an amended pay package—after reincorporating.  That would raise another thorny question:  given that the new pay package would largely moot the benefit in Tornetta, is there a mechanism to make the plaintiffs’ firms give the fees back?

5. Tesla Might Adopt Fee-Shifting Bylaws and Texas May Make Additional Legislative Reforms.

The Texan legal environment could provide Tesla with further protection against inevitable stockholder litigation.  While Delaware’s corporate statute is notably flexible, it has limits—such as its famous prohibition against corporations adopting bylaws requiring unsuccessful stockholder litigants (or their attorneys) to bear a corporation’s legal fees.  Professor Bainbridge described this ban as “Delaware’s self-inflicted wound.”  Several states adopted similar legislation after Delaware did so.  To my knowledge, Texas has not.  A post-reincorporation Tesla could potentially make itself a less-attractive target by requiring plaintiffs—whose lawyers make millions, and potentially billions, by suing the firm—pay fees when they fail.

Tesla’s Delaware experience already puts the lie to the old plaintiffs’ saw that fee-shifting bylaws are “one-sided” in favor of corporations.  While the popular observation is that Tesla won its derivative litigation over SolarCity, it is more accurate to say that Musk won, and won again on appeal. Every other director settled before trial for $60 million (from insurance), and the SolarCity plaintiffs received over $16 million in fees.  Tesla did not get the fees back, or its own fees covered, after plaintiffs lost.  As Professor Griffith puts it, with only slight exaggeration, in Delaware stockholder litigation “the starting point is not the American Rule, under which each side bears its own fees, but rather the Delaware rule, under which the corporation always pays.”  Texas might correct this imbalance.

Texas could consider other reforms.  For instance, Reuters reported that the Tornetta plaintiff is a former drummer who owned only nine shares.  The Tornetta opinion, however well-reasoned, eloquently constructed, and doctrinally correct, remains just that:  an opinion.  It has the force of law because a tiny stockholder, backed by one of the world’s wealthiest law firms, convinced a judge.  That procedure overrides the opinions of other stockholders, including the vast majority who voted in favor of Musk’s pay, because Tesla did not fully disclose all material facts when it asked for stockholder approval.  Again, as a matter of Delaware doctrine, this fits:  an omitted fact need not change the outcome of a stockholder vote, or even sway any stockholder’s vote, to be material.  Thus, Tornetta faults Tesla’s failure to disclose that certain directors were not “independent” and that Musk and another director discussed his pay before the Compensation Committee did.  But while the reasoning is doctrinally sound, the result has an Alice-in-Wonderland feel to it.  I’d be surprised if one could find more than a few dozen stockholders who would have changed their votes based on that fact, much less enough to affect the outcome.  Again, Matt Levine has a point:

But I think that if you put it to a vote of Tesla shareholders — “would you rather give Musk $55.8 billion of Tesla stock for running Tesla, or these lawyers $1 billion of Tesla stock for suing Tesla?” — you’d get a pretty large majority for Musk? I’m not Musk’s biggest cheerleader or anything, but I feel like he has probably done a lot more for Tesla than these lawyers have.

But in Delaware, the stockholders who disagree with the Tornetta plaintiff lack a mechanism to stop his lawsuit, even if other stockholders are much larger investors.  Texas could consider legislative reforms that would strengthen corporate democracy, perhaps by requiring derivative plaintiffs to hold significant stakes before they can sue to redirect corporate decision making.  I suspect that, if Tesla does reincorporate, the enthusiasm of the Texas legislature for other innovative reforms will intensify.

Of course, Tesla may not ultimately decide to reincorporate.  Right now, the only indication that it will do so is Musk’s tweet.  This may be much ado over nothing.

5. Conclusion.

            Still, I can’t end this post without addressing what most other commentators have pondered:  how does a potential Tesla reincorporation affect Delaware?  Professor Bainbridge concludes that, after Tornetta, “Delaware’s dominance will be preserved” because the decision demonstrates that Delaware will hold even one of the richest CEOs in the world to account.  That is the conventional wisdom.  And I hope Professor Bainbridge is correct.  I’m a Delaware lawyer, after all.  But that may be the wrong question.

In the recent debate between former attorney general William Barr and Vice Chancellor Laster, both discussed the New Jersey policy failures that led most corporations to move to Delaware over a century ago.  But history need not repeat itself, it merely needs to rhyme.  If Texas took 20 percent of Delaware’s corporations—or over the long term, attracted 20 percent of new firms—its new business court would turn the Lone Star State a tidy profit.  The same loss to Delaware would perhaps not be apocalyptic for the First State’s finances, but it would certainly be uncomfortable.  A still-dominant but less-dominant Delaware is not an optimal outcome, at least for my home team.

And, returning to my first point, the new competition may become a matter of “vibes.”  Delaware law provides a broad enabling statute, and then every decision may be “twice tested” for compliance with both law and equity.  The second test takes place in lengthy, expensive legal proceedings, and the results are not always predictable.  (Take James Murdoch, former CEO of 21st Century Fox and himself wealthy beyond my imagining even apart from his Tesla investment.  I did not attend the trial and I have not reviewed the evidence as the Chancellor has.  But if you had asked me a month ago whether Murdoch was independent of Musk, I would have thought so.)  For established, mature companies, Delaware’s equity-based jurisprudence may be ideal.  But newer companies with differing business cultures—even companies whose CEOs don’t produce flamethrowers—may find more certain legal paradigms more attractive.  Tornetta provides a potential roadmap for states that want to compete with Delaware:  corporate law based less on equitable principles, with more clearly defined safe harbors for director conduct. 

And while it has gone largely unremarked, the nature of state competition has changed since I co-authored a paper about it over a decade ago.  In the early 2000s, most business courts imitated the Court of Chancery.  Today, not only do they seek to differentiate themselves, but reforms—for instance, Nevada’s elimination of “inherent fairness” review and the Texas class action rules—are more often driven by legislatures rather than lawyers.  The Texas legislature created its new business court despite substantial opposition from some local legal associations.  By contrast, Delaware corporate legislation tends to be driven by the Delaware bar.  Differing political economies may adopt different reforms that are attractive to different types of corporations.

Finally, I’ll end on a personal observation.  It is not my intent to criticize the Tornetta decision’s legal reasoning.  That is a task for other practitioners on appeal.  The simple fact is that once a Delaware stockholder files a derivative complaint, a court must reach some decision:  even if the parties settle, the settlement must be judicially approved.  No opinion can satisfy everyone.  But my mind keeps uneasily turning back to Tornetta’s criticism of the “cooperative and collaborative process” that led to Musk’s pay package.  In fairness, Tornetta addresses my discomfort in footnote 733, assuming that perhaps “some level of cooperation and collaboration is called for” but that Tesla exceeded that level.

Still, that phrase pulls at the businessman in me that preceded the lawyer.  Law firms, and particularly BigLaw firms, may have zero-sum distribution negotiations in partners meetings and lockstep compensation among associates, but that was never my expectation of work before law school.  I didn’t join the bar until my early thirties.  Before that, I was never a CEO or a director, but I did lead small teams and conduct salary negotiations.  Perhaps my former teammates would not describe my discussions with them as a “cooperative and collaborative process,” but I hope they would.

Before my legal career, I would never have imagined that anything approaching adversarial salary negotiations were necessary for a process to be fair.  Again, perhaps it’s “vibes,” but those passages about cooperation make me think that the conventional wisdom may be more fragile than we expect, and Tornetta more consequential.

Guest Post from Andrew A. Schwartz: A Missing Piece in Regulation Crowdfunding

I write today to highlight a significant market failure in the field of investment crowdfunding, one that the current set of rules does not adequately address. At the end of the post, I will propose a simple rule that the SEC can adopt to resolve the problem.

Investment crowdfunding—the public offering of unregistered securities through an independent online platform—generally calls for a light-handed set of regulations, for a number of reasons, including: One, an issuer may only raise up to $5 million at a time, and so the regulatory cost must be minimal to make it work. Two, we already have a heavily regulated form of public offering, namely the traditional IPO; investment crowdfunding is meant to be a simpler method of public fundraising. Three, each issuance is at such a small scale that no single blowup can cause anything close to systemic harm.

Thus, in my recent book, Investment Crowdfunding, I advocate for a liberal regulatory system that eschews many of the traditional bulwarks of securities regulation, including mandatory disclosure. Even so, there are certain areas where the market, left to its own devices, will not produce an optimal result, and thoughtful regulation can help achieve a better outcome for all concerned.

As I discuss in my book, there is a problem with the ‘all-or-nothing’ model of crowdfunding. Under the JOBS Act, crowdfunding issuers must announce a target funding amount, and a time frame to reach it. If enough investors contribute within the relevant time to hit the target, the deal succeeds, the company gets the money, and the investors get securities. But if a project fails to meet its target, then the deal is off and no money changes hands. Hence, the issuer gets either ‘all or nothing.’ Companies must also announce a maximum amount they are willing to take.

This all-or-nothing model is a key governance mechanism for the investment crowdfunding market. Based on the ‘wisdom of the crowd,’ good companies will get funded and bad companies won’t. Moreover, any individual investor who selects a bad (unpopular) investment will be saved from his poor choice, because it won’t reach its target funding amount, and the deal will be cancelled. Rather than walk off the cliff alone, such an investor will be pulled back to safety by his fellows.

Consider, for example, a company that wants to raise money to develop a new type of electric car battery and sets a target of $2 million. If it only can get $20,000 worth of investments, it is much better for the deal to be canceled than for it to go through. The poor investors would have all their money eaten up by the costs of raising it, and the company has no chance of developing the battery with only $20,000. Furthermore, the founder now knows that the market is not receptive to his proposed idea, so he may pursue some other endeavor, or at least make drastic changes to this one.

All this shows the value of the all-or-nothing model. Unfortunately, the simple version enacted in the JOBS Act and Regulation Crowdfunding can be gamed by companies and platforms, because there is no minimum target in the law, and no relation between the minimum and the maximum. Thus, there is nothing to stop a company from setting its funding target at some absurdly low level, say $100, and the maximum at, say, $1 million. Once that low bar is cleared, the company is home free and will get the money regardless of how little or how much is ultimately raised—and the platform will receive its commission for hosting a ‘successful’ offer. Unfortunately, this is not at all merely hypothetical but appears to happen every day.

Rather than setting the funding target on an individual basis, the leading American platforms appear to impose uniform funding targets on all, or nearly all, of the companies they list. One leading platform sets the funding target at $50,000, another sets it at $25,000, and a third requires that every company on its site set a funding target of just $10,000. This practice defeats the purpose of the all-or-nothing rule, as it effectively ensures that every company will meet its target and thereby ‘succeed’ in its crowdfunding campaign.

But it is a bit silly for a company that really needed $2 million to call it a success to have raised $20,000. In fact, it’s worse than silly, since the whole $20,000 will go toward the costs of raising the funds (audit fees, for instance), harming the company and the investors at the same time. The platform, by contrast, might not mind, since it receives its commission (which it would not get if the offer were to fail).

Furthermore, because the rule allows for any minimum and maximum, companies routinely select a minimum of $10,000 and a maximum of $1 million. This is bonkers. A company that seeks to raise anywhere between $10,000 and $1 million clearly has no idea what amount of funding it actually needs.

An additional problem with the rule in Regulation Crowdfunding is that there is no legal limit on the deadline, so companies routinely give themselves many months, or even a year or more, to reach their funding target. This is a common occurrence on all platforms, as crowdfunding companies can close the offering ‘early,’ so long as they give the investors forty-eight hours to cancel.

The effect of such a long time-frame is to undermine the whole point of having a deadline in the first place, which is to test the crowd’s appetite for what the company has to offer. In addition, it may also harm the company by keeping its attention on the crowdfunding campaign for many months, rather than getting on with business.

In the end, the all-or-nothing model is a useful structure, but it is not presently working well. I accordingly would recommend that Regulation Crowdfunding be revised and tightened up to prevent the sort of gaming we have seen to date.

One way to address the low-target problem is to create a new rule that links the maximum to the funding target, such that a company is only legally allowed to raise a certain multiple (perhaps four times) of the funding target. For example, if a company announces a funding target of $20,000, it would only be legally allowed to raise up to a maximum of $80,000 (assuming a four-times multiple). If it announces a target of $250,000, it can raise up to $1 million.

A rule like this would effectively force a company to think carefully about how much funding it really needs and would rehabilitate the power of the all-or-nothing model in the United States. Were such a rule in effect, platforms would not have their listing companies all use a standard funding target like $10,000 or $25,000, as they commonly do now. This would be a big change from the current practice, but a good one, I think.

If my proposed rule were enacted, a crowdfunding company would have to analyze its individual circumstances and set its funding target at an amount that it actually needs to raise. Typical funding targets would likely be in the range of $100,000, $250,000, or even $1 million (as we see in other jurisdictions). Having to reach those lofty targets in order to get a penny would present a real test of the investors’ view of the company—which is exactly the point of the all-or-nothing regime.

In addition, there should be some regulatory guardrails on the deadline as well. Regulation Crowdfunding should be amended to include a legal limit on the length of time that a crowdfunding offer can remain open. Both Canada and Australia have done just that, imposing a legal limit of ninety days, which seems like a reasonable choice. This concentrates the discussion among the crowd and allows the company to raise money and then get back to its primary business, whatever it may be.

In conclusion, although I generally support a liberal and light-handed approach to investment crowdfunding regulation, I would call on the SEC to add a new rule that enhances the effectiveness of the all-or-nothing concept. My proposal is to add a rule that limits an issuer to raising four-times the target amount, and to impose a ninety-day time limit for crowdfunding offerings to remain open.

Andrew A. Schwartz, Professor of Law at the University of Colorado and Fulbright Scholar, is the author of Investment Crowdfunding (Oxford University Press 2023), from which this post was adapted.

Guest Post from Jeffrey Lipshaw: Who owns the corporation?

[My friend and occasional sparring partner Jeff Lipshaw sends along a reaction to my post on “who owns the corporation?”]

Typical of most Quora questions, that one is slightly inane, because whether the shareholders "own" the corporation is at least worthy of a thoughtful response like yours, but before you explain to somebody that the CEO doesn't own it, you might need to disabuse them first of a couple Q-Anon theories on the deep state.

So I agree with your legal analysis of "ownership" of the corporation.  I agree, for example, that nobody other than a shareholder (not the union, not the government, not customers) has legal standing to complain about whether a board decision is in the best interest of the corporation.

Nevertheless, you ought to include a disclaimer when you say, "the corporation is an aggregation of people bound together by a complex web of contractual relationships."  In other words, "the web of contracts" concept is meaningful if you are looking at it through a legal lens.  And the legal lens itself imports what a sociologist might call a Gesellschaft view - a modern institution built on ownership rights embodied in law (per Ferdinand Tönnies, in contrast to the tribe or community Gemeinschaft).

Humor me with an analogy.  Who owns Detroit?  Residents?  Taxpayers?  Voters?  Is a city a thing? Ownership is as illusive a concept there as with the corporation.  One way of looking at the city is as an aggregation of people bound together by a complex web of constitutional, statutory, regulatory, and contractual relationships.  That is a pretty limited view.  There are myriad sociological, historical, political, psychological, anthropological relationships and norms that also have some explanation oomph in characterizing a city.  See, e.g., Susan Silbey on snow day placeholders.  I agree that most of them don't matter if, for example, the question is whether you are a resident for the purpose of the city income tax.

To hit closer to (your) home, who owns the Roman Catholic Church?  I actually litigated something like that years ago regarding some church property in Detroit.  Assume the deed to the church property says, “any transfer of this property to one not a true believer in the holy Roman Catholic catechism is void ab initio.” There is a schism in the congregation. The trustees sell the property to Group A.  Group B sues to void the transfer on the grounds that the members of Group A do not satisfy the condition.  The constitutional law principle is that the court will only look at legal title, and will not enforce a provision that would require it to decide a religious question.  So law will give a result, but is that really the right answer in light of all the norms that govern that community?

The same applies to a corporation, which I'd suggest is more than the sum of its legal contracts in the same way that a corporate acquisition is far more than the contracts that document it. (I speak from some personal experience. The lawyers think that they are running things because the funds don’t transfer or the certificate of merger doesn’t get filed until all the conditions of the contract get satisfied, but trust me when I say that the business unit and functional leaders responsible for deriving the synergies don’t see it that way. The documents are the metaphor skeleton of the transaction, but the business consists of organs, muscle, and tissue not reflected there.)  

I concede you didn’t take it that far, but I think the “web of contracts” approach makes easier for you to justify the shareholder wealth maximization principle, something about which we have had a nice debate.  The utilitarian approach only measures a certain kind of welfare in a certain kind of way and thus itself bespeaks the answer.  It’s not a given that it has to be that way:  compare European codetermined corporate governance. It’s fair to argue that the SWMP is normatively the way to go, but if you argue it purely from law and economics premises, you should be forthright about the implicit assumptions you’ve made.  And the corporation as “web of contracts” invokes those assumptions.

Guest Post by U Oregon Law Professor Mohsen Manesh on Lee v. Fisher

Last week, in Lee v. Fisher [1], the Ninth Circuit en banc issued a consequential decision calling into question the scope of the implied right of action recognized by J.I. Case Co. v. Borak [2] and creating a stark split with the Seventh Circuit. Prof. Ann Lipton has blogged extensively about the case. Readers of this blog will recall that Prof. Bainbridge has also discussed Lee, commending the amici brief submitted by Joe Grundfest and I for its “audacity,” but expressing some skepticism the Ninth Circuit would agree with us.

Ultimately, the Ninth Circuit did agree with us, and Prof. Bainbridge kindly invited me to provide this update.

The Rise of Derivative Borak Suits

In 1964, the Supreme Court in Borak held that, under Section 14(a) of the Exchange Act, shareholders enjoy an implied private right of action to bring claims for false or misleading proxy statements. Importantly, Borak explained that a shareholder lawsuit under Section 14(a) may be brought as either a direct action, on behalf of individual shareholders, or a derivative action, on behalf of the corporation.  As the Borak Court stridently asserted,

The injury which a stockholder suffers from corporate action pursuant to a deceptive proxy solicitation ordinarily flows from the damage done to the corporation, rather than from the damage inflicted directly upon the stockholder. The damage suffered results not from the deceit practiced on him alone but rather from the deceit practiced on the stockholders as a group. To hold that derivative actions are not within the sweep of the section would therefore be tantamount to a denial of private relief. [3]

As Grundfest and I have explained, in recent years, as Delaware courts have cracked down on meritless shareholder litigation, the plaintiff’s bar has sought refuge in federal courts by bringing derivative Borak claims. These federal derivative suits allege corporate harm arising from the board’s mismanagement of matters ranging from executive compensation, to oversight of regulatory compliance, to corporate policies concerning diversity, equity and inclusion. Stated differently, these derivative suits concern internal corporate affairs—matters that are traditionally governed by state corporate law and, therefore, more sensibly litigated in the Delaware Chancery. But rather than bringing a state law claim for breach of fiduciary duty in Delaware courts, these federal derivative suits make the more tortured argument that the alleged corporate harm was a result of the shareholders being misled by the company’s proxy statement. In doing so, derivative Borak lawsuits transparently aim to establish federal court jurisdiction and, thereby, avoid the likely fate that such suits would face before a skeptical Delaware judge.

Lee v. Fisher

The suit in Lee exemplified this trend. In Lee, the plaintiff-shareholder brought a derivative Borak claim in federal court against the directors and officers of The Gap, alleging failures in the management’s efforts to promote racial diversity within the company’s leadership ranks.  As a derivative suit, the Lee plaintiff alleged that The Gap’s proxy statements had included materially false or misleading statements about the company’s efforts to pursue diversity, which in turn harmed The Gap by enabling the re-election of the company’s incumbent directors and approval of the officers’ compensation packages.

The Gap sought to dismiss the derivative suit by invoking a forum provision in its corporate bylaws that required all derivative suits to be litigated in the Delaware Chancery Court. Because federal courts have sole jurisdiction to hear Exchange Act lawsuits, directing all derivative claims to the Delaware Chancery would effectively preclude the plaintiff’s derivative Borak suit. Nevertheless, the Ninth Circuit en banc ruled that the forum bylaw is enforceable against the plaintiff, both as a matter of Delaware law and federal law, and dismissed the plaintiff’s federal derivative lawsuit.

Practical Implications

Lee has immediate practical implications. In the Ninth Circuit, corporations may now use a forum bylaw to force all derivative claims into the Delaware Chancery and, thus, eliminate federal derivative Borak suits altogether. Shareholders remain free to bring (i) the same Borak claim as a direct or class action to recover any damage they suffered personally and (ii) a derivative action under state corporate law to recover any damage suffered by the corporation. But duplicative federal derivative suits brought under Borak can be quashed by a corporate forum provision that requires all derivative suits to be filed in Delaware. As Alison Frankel observes, “If [Lee] is right, a whole category of shareholder suits can be erased.”

Doctrinal Implications

Beyond the immediate practical implications, Lee has doctrinal significance. Citing our forthcoming Business Lawyer article, Lee ruled that Borak’s recognition of an implied derivative right under Section 14(a) is dicta and not binding precedent. [4] In doing so, Lee wholeheartedly embraces our article’s argument that, under the Supreme Court’s post-Borak precedents, the implied right of action under Section 14(a) is limited to direct claims only.  

As we explain in the article, ever since Borak was decided, the Court has repeatedly criticized the 1964 precedent [5] and told us that it must be narrowly interpreted. [6] Moreover, the Court has said, and reiterated, that state law—not federal common law—defines what a derivative action is. [7]

Looking to state law, Delaware is unambiguous. “[W]here it is claimed that a duty of disclosure violation impaired the stockholders' right to cast an informed vote, that claim is direct.” [8] The claim is direct, not derivative,  because “where a shareholder has been denied one of the most critical rights he or she possesses—the right to a fully informed vote—the harm suffered is almost always an individual, not corporate, harm.” [9]

Any lower court that spends time examining the Court’s post-Borak precedents would conclude that Borak’s implied derivative right of action is nonbinding dicta, as the Ninth Circuit has now done, and that private Borak suits are limited to direct claims only. Even in the absence of a corporate forum bylaw directing all derivative suits to Delaware, there is no cognizable federal derivative cause of action under Section 14(a) to begin with.

The Circuit Split

Significantly, the Ninth Circuit’s decision in Lee squarely conflicts with an earlier Seventh Circuit ruling in Seafarers v. Bradway. [10] In Seafarers, a bare majority of a three-judge panel ruled, over the dissent of Judge Easterbrook, that a corporate forum bylaw, identical to the one at issue in Lee, is unenforceable against a derivative Borak suit, both as a matter of Delaware law and under the Exchange Act’s anti-waiver provision.

The Ninth Circuit en banc in Lee concluded that Seafarers was wrong as to both Delaware and federal law. On the former, as we explain in our paper, Seafarers was clearly wrong, a belief that is supported by a venerable cadre of former Delaware Chief Justices, Justices, Chancellors, and Vice Chancellors who submitted a separate letter to the Ninth Circuit. The Delaware Supreme Courts’ landmark 2020 decision in Salzberg v. Sciabaccuchi [11] plainly establishes that a corporate forum provision may regulate shareholder rights arising under federal securities law.

Borak is in Jeopardy

Given the stark split now opened between Seafarers and Lee, and the fact that both decisions generated pointed dissents, it seems likely that the Supreme Court will be revisiting Borak at some point. Even if the plaintiffs in Lee don’t seek cert, perhaps because they fear the Supreme Court precedent that might result, we now have a consequential circuit split on the meaning of Borak. This issue is certain to come up in other circuits.

In 2019, when the Supreme Court took cert in Emulex v. Varjabedian, involving the implied right of action under Exchange Act Section 14(e), much of the Court’s attention was focused on Borak and what it meant for implied rights of action under Section 14. During oral arguments, the Chief Justice remarked that “we now know that [Borak] was not the right approach,” that “Borak would not be decided the same way today,” and that, “from today’s perspective, what we did back then [in Borak] was a mistake.” Ultimately, the Court dismissed cert in Emulex as improvidently granted because that case dealt with Section 14(e), rather than Section 14(a). But it was clear at that time that the Court was really interested in revisiting Borak. Lee, or another case like it, squarely presents the Court with that opportunity. At that point, the whole entirety of Borak may be in jeopardy.

The Restatement Reporters Reply

A recent post criticized the Restatement of the Law of Corporate Governance's approach to the law of controlling shareholders. The Reporters have sent along this response:

In your blog post, you take issue with two elements of Section 5.10, which was approved by the ALI at its May 2022 annual meeting.

The first element relates to the types of transaction in which a controller is considered to be interested. Your blog post suggests that the restatement is taking an approach that is “entirely different” from the Delaware Supreme Court’s approach in Sinclair Oil. v. Levien, 280 A.2d (Del. 1971). Yet, the restatement is completely consistent with Sinclair Oil. Under section 1.23, which defines “interested” and is referenced in section 5.10, a controller is interested if the controller “receives a benefit … when the benefit … is not shared with shareholders pro rata …”. The issue in Sinclair Oil was whether a parent was conflicted as to a dividend paid by its non-wholly owned subsidiary.  The dividend was paid pro rata to the parent and the subsidiary’s minority shareholders.  The Delaware Supreme Court held that there was no conflict—a sound decision and one with which the restatement fully accords, both in its black letter and in comment 3.  Sinclair Oil also deals with another issue: whether the parent usurped a corporate opportunity belonging to the subsidiary. But corporate opportunities involving controllers are addressed neither by section 5.10 nor by section 1.23 (they will be addressed by a different provision yet to be drafted) and these sections can thus hardly take a different approach to that issue than did Sinclair Oil.

The second, and more important, element you take issue with relates to the standard of review that applies when a controller is interested in a transaction involving a controlled entity.  Absent a cleansing act, there is broad consensus that a fairness standard applies.  But what if there was a cleansing act?  Under Kahn v. Lynch, a 1994 decision by the Delaware Supreme Court that has been followed by other jurisdictions that have addressed that issue, a single proper cleansing act has the effect of shifting the burden of proof on fairness, rather than of reinstating the business judgment rule. And under MFW, a 2014 decision by the Delaware Supreme Court that has been followed by New York but has been rejected by Oklahoma, two proper cleansing acts have the effect of reinstating the business judgement rule. 

Both Lynch and MFW involved freeze-out mergers. But Kahn v. Tremont, 694 A.2d 422 (Del. 1997) involved a regular self-dealing transaction between a Valhi (an entity owned Simmons) and Tremont (an entity controlled by Simmons). In Tremont, the Delaware Supreme Court noted:

Ordinarily, in a challenged transaction involving self‑dealing by a controlling shareholder the substantive legal standard is that of entire fairness, with the burden of persuasion resting upon the defendants. Weinberger v. UOP, Inc., Del. Supr., 457 A.2d 701, 710 (1983). The burden, however, may be shifted from the defendants to the plaintiff through the use of a well-functioning committee of independent directors. Kahn v. Lynch Communication Sys., Del. Supr., 638 A.2d 1110, 1117 (1994).

Id. at 428.

Subsequent to Tremont, a plethora of Chancery court cases have applied the Lynch framework in settings other than freeze-out mergers. The notes to section 5.10 list over 10 such opinions by the Chancery court, of which about half are reported.

To be sure, the blog is correct in noting that several of these opinions pre-date MFW. But the relevance of this point escapes me. MFW does not speak to the issue of which transactions are subject to Lynch to start with. Moreover, I do not think that there is anyone who has argued that, under Delaware law, a transaction that is subject to the Lynch rule, meaning that a single cleansing merely shifts the burden under a fairness test, is not also subject to the MFW gloss on Lynch, meaning that two proper cleansing acts reinstate the business judgment rule. The relevant date for whether a Delaware court decision elucidates the scope of Lynch is thus the date when the Lynch rule was announced, not the date when it was clarified by MFW.  And all the cited cases post-date Lynch.

Several leading commentators, including two highly respected former Delaware judges, have criticized these Chancery court decisions.  There are certainly cogent arguments for limiting the scope of transactions subject to the Lynch rule, as there are cogent arguments in the other direction. But when the weight of judicial authority is overwhelmingly in one direction—and for these purposes, law review articles by former members of the judiciary do not constitute judicial authority—the role of the restatement is not to evaluate these policy arguments, or to predict rulings by the Delaware Supreme Court in a yet-to-be-filed case, but to restate the law as it stands today.  And that is what Section 5.10 has done.

JB Heaton and Todd Henderson Respond: They Think Twitter's Lawsuit is a Loser

I offered JB Heaton and Todd Henderson an opportunity to do a guest post responding to my post, Does Twitter's Lawsuit Against Elon Musk Really Look "Like a Loser"?, which had commented on their WSJ oped on the lawsuit:

J.B. Heaton and Todd Henderson

July 18, 2022

Thank you to the inestimable Steve Bainbridge for allowing us the opportunity to discuss the Twitter v. Musk lawsuit here. In our discussions with investors betting on the outcome, we heard that they all read Steve’s blog, confirming it as the essential place for corporate law commentary. This is a close case, and we are grateful for and fascinated by the ongoing debate.

Our Wall Street Journal commentary has provoked considerable discussion. Some of it serious and excellent (such as Steve Bainbridge on this blog and Yair Listokin Jonathon Zytnick in the New York Times); some of it the equivalent of the ranting of a hypoglycemic child. Some of it agrees with us; some of it does not. Of course, that’s why we have such opinion pieces: to state an opinion, usually on one side of an issue that might be seen differently by different people. Our original piece rose out of our own discussions on the Twitter v. Musk lawsuit, and primarily in response to what we saw as a chorus of agreement that Elon Musk was almost certain to be forced to close the deal he and his holding corporations made with Twitter, Inc. Clinical professors of marking, professional pundits, news anchors, and even constitutional law professors were suddenly experts on corporate law and M&A, and they all thought it was obvious that Musk would be forced to buy Twitter, even though it is far from clear this is something anyone (other than merger arbs invested in Twitter stock) wants to happen. If the Delaware courts are going to get this right, we thought it important to offer the other side of the case.

Our point is that specific performance is by no means the sure thing many pundits claim. The proof of the reasonableness of our view is in the pudding of Twitter, Inc.’s stock price. That stock price closed on Friday, July 15, 2022 at $37.74. The deal price that so many believe Musk will be ordered to pay is $54.20. As a back of the envelope calculation, if the average of all of the possibilities for the stock price without specific performance is, say $30.00, then the current stock price reflects about a 32% chance of specific performance. Maybe the case will settle for an amount less than $54.20, but if it were clear specific performance was an obvious option for Twitter, that settlement would be about $54.20 minus the cost of litigation, or about $54.20.  There are many ways to think about the possible outcomes of course, but there is no question that people with real money on the line are not viewing specific performance as even more likely than not, and definitely not as the slam dunk many commentators claim.

Could the Delaware Chancery Court order specific performance and could that ruling be affirmed on appeal? Of course. We don’t think otherwise. Has the same court ordered specific performance in the past? Of course. Enough times so that “rarely” is the wrong word? Perhaps. Remember, we had editors at the Wall Street Journal and they love to punch up their pieces. If we’d been mealy mouthed and hedged like lawyers do, we are doubtful the debate today would be as joined and as valuable as it is.

The question is whether specific performance is likely here. This case is not the same as the prior cases. For one thing, Musk’s lawyers at Quinn Emanuel will leave no stone unturned on the remedy of specific performance. This will not be IBP v. Tyson Foods, the 2001 case where then-Vice Chancellor Leo Strine observed that “[a]lthough Tyson’s voluminous post-trial briefs argue the merits fully, its briefs fail to argue that a remedy of specific performance is unwarranted in the event that its position on the merits is rejected” and where VC Strine observed that “[t] his gap in the briefing is troubling.” Quinn Emanuel won’t make that mistake. This case will be as much about the remedy as Musk’s defenses on the merits.

It should also be noted that the Tyson case was under New York law, not Delaware as in the Twitter case, that the court took into consideration the impact on all of the various corporate stakeholders, not just shareholders, and, most importantly, in asking whether the opportunity was truly “unique,” the court asked the same question we did in our oped, and noted that the decision to require specific performance was not one the court was confident about. In other words, in a highly contextualized analysis, the court found the case to be about a coin-flip.

In the Twitter case, Quinn Emanuel is likely to home in on the serious legal problem in Twitter, Inc.’s case with respect to specific performance: Twitter, Inc. is not obviously even harmed by the breach.

Corporations, as all readers of this blog know, are legally separate and distinct from their shareholders. Suppose a corporation enters into an agreement to merge with another entity, and under that agreement the corporation will cancel its existing shares, giving its then-former shareholders the right to receive money from the acquirer, although that money never enters the corporation itself. If the acquirer breaches its agreement and refuses to close, the shareholders will not receive the money promised to them by the agreement but the corporation itself will receive $1 billion (in the form of a termination fee) that it did not have before and would not have received if the merger proceeded. What rights do the shareholders have under Delaware law if the merger agreement disavows them as third-party beneficiaries for purposes of enforcing the agreement? Can the corporation itself ignore the benefit it receives from breach (the $1 billion termination fee) to ask a court to specifically enforce the merger agreement and, if it does, would it be lawful for the Delaware courts to award specific performance?

We think this is the situation presented by the case of Twitter v. Musk. There is an agreement and plan of merger among Twitter, Inc., a Delaware corporation, and X Holdings I, Inc. and X Holdings II, Inc. In the merger agreement, X Holdings I, Inc. is known as the Parent and X Holdings II, Inc. is known as the Acquisition Sub. The merger agreement reflects a plan for a so-called reverse triangular merger under which Acquisition Sub merges into Twitter, Inc. with Twitter, Inc. surviving to become a wholly-owned subsidiary of the Parent. Under the merger agreement, Twitter, Inc. cancels its existing shares and replaces them with certificates that then-former Twitter, Inc. shareholders can take to a bank acting as paying agent, receiving $54.20 for every former share of Twitter, Inc. stock held as reflected in the certificates.

Twitter, Inc.’s shareholders before the merger becomes effective are not parties to the merger agreement, and the merger agreement disavows those shareholders as third-party beneficiaries except as to a provision limiting Twitter, Inc.’s money remedies to a $1 billion termination fee, the purpose of which is to bind Twitter, Inc.’s shareholders to that part of the agreement without giving them wider rights. The merger agreement also entitles Twitter, Inc. to that $1 billion termination fee as one of three possible and mutually exclusive remedies, the other two being, first, a damages remedy capped by the amount of the termination fee ($1 billion) and so no better than and possibly worse than the termination fee and, second, the right to ask for specific performance.

On July 8, 2022, Musk (who is also a party to portions of the merger agreement), Parent, and Acquisition Sub purported to terminate the agreement. Twitter, Inc. sued Musk, Parent, and Acquisition Sub in Delaware Chancery Court alleging that the termination was wrongful and that the court should order Musk, Parent, and Acquisition Sub to close under an equitable remedy of specific performance.

Suppose that the Musk termination was wrongful. Should the court grant specific performance? To both lay persons and lawyers who spend little time on the legal distinction between a corporation and its shareholders, the appealing answer is, Yes. After all, Musk, Parent, and Acquisition Sub made a deal with Twitter, Inc. and under that deal the Twitter, Inc. shareholders would receive $54.20 per share, a huge premium over the Twitter, Inc. share price before Musk’s interest in acquiring Twitter, Inc. became public. Specific performance is worth as much as $30 per share at this point, assuming that a loss on specific performance might see the Twitter stock fall to $24.20 or so. By contrast, a $1 billion termination fee paid to Twitter, Inc. (not to its shareholders) is worth only about $1.30 per share, approximately 9% of which will accrue to Musk’s benefit as owner of about that percentage of Twitter, Inc. stock. Specific performance surely is the only remedy that can compensate Twitter, Inc.’s shareholders for the lost deal premium.

But not so fast. The readers of this blog can see that the problem for the court is this: Twitter, Inc. is not obviously harmed by the breach. Form matters in these things. Twitter, Inc. is the surviving corporation in the reverse triangular merger reflected in the merger agreement. Twitter, Inc.’s assets and profits are exactly the same in the instant after the merger becomes effective as they were in the instant before the merger became effective. In fact, if Twitter, Inc. collects the $1 billion termination fee as its remedy (and we assumed it can; debate on that point is small potatoes), then Twitter, Inc. is $1 billion better off than it would have been had the merger closed.

That is, Twitter, Inc., the corporation, suffers no harm and, even if it did suffer some, there’s no indication that the $1 billion termination fee would leave Twitter, Inc. anything other than financially better off than it would have been with the merger, even if some of the $1 billion does compensate Twitter, Inc. for de minimis harm from, say, legal and consulting fees in pursuing the termination fee in court.

Twitter’s shareholders are obviously injured by the loss of the deal to have their stock cancelled and replaced with certificates that then would be presented to a paying agent funded by Parent. But shareholders have no damages remedy in the merger agreement for injuries that are separate and distinct from any injury to the corporation. Twitter, Inc. might have negotiated for that right but it did not, except that it asserted that it could seek damages for shareholder losses as well, but only up to $1 billion. Twitter, Inc.’s shareholders have no right of their own to pursue specific performance under the merger agreement.

This leaves the Delaware courts in a predicament. To order specific performance of the deal is to order contract parties to perform so that non-parties to the contract (the Twitter, Inc. shareholders) who were expressly disavowed as third-party beneficiaries for remedy purposes can receive payment for cancelled shares, even though an award of the termination fee would leave the legally distinct and actual party to the contract, Twitter, Inc., better off by $1 billion than would specific performance, which will leave Twitter, Inc. exactly as it was except for a new board of directors and new bylaws taken from the Acquisition Sub and the replacement of its pre-merger shareholders with a single shareholder, Parent. 

In substance under the merger agreement, Twitter, Inc. is acting as a commission-free broker of a deal where current Twitter, Inc. shareholders agree to have their shares cancelled in return for a payment and Musk’s parent holding company agrees to make that payment in return for  ownership of Twitter’s (one) new share. But rather than make a contract among shareholders and Musk and his holding companies, as a broker would do, Twitter, Inc. made itself the counter party to Musk and his entities. But as a commission-free broker, Twitter, Inc. loses nothing when the deal collapses. In fact, having negotiated a termination fee of $1 billion, Twitter, Inc. is actually better off with breach and that remedy than with either its limited (to $1 billion) damages remedy or specific performance. And shareholders, being nonparties disavowed as third-party beneficiaries, have no separate cause of action. Only by ignoring the legal distinction between Twitter, Inc., the corporation, and Twitter, Inc.’s pre-merger shareholders could specific performance make sense.

Of course, there is virtue in deal certainty. Parties may want to bind themselves, as Odysseus did to the mast. But Delaware courts scrutinize such acts of pre-commitment routinely, forbidding some kinds, as under the Unocal doctrine. One of our many points is that specific performance is, from a law and economics perspective, a bad deal device in all but a few kinds of cases. It would be better for the parties to contract in other ways, such as by including shareholders as third-party beneficiaries (and thus making the damages from a broken deal easily available). Deal structure matters. For instance, given the nature of the parties, it might have made much more sense for the Twitter board to let Musk deal directly with shareholders (as he wanted) than to force him to deal with the board. The poison pill may have been the original sin, since courts and the bluntness of specific performance would not have been needed had Musk been allowed to tender for Twitter shares.

Judges have ways of working around the law, and specific performance may well be awarded by a court that is loath to allow Musk, Parent, and Acquisition Sub to walk away from a $44 billion deal for a measly $1 billion.  To do so here, however, the Delaware court will have to ignore the most fundamental fact of corporate law, namely, that the corporation is not its shareholders. Wouldn’t that be a strange outcome in Delaware, of all places. Could it happen? Sure. It is more likely than not? We think no, and the stock market, so far, agrees with us.

Jeff Gordon on Elon Musk and Twitter

My friend Columbia University Law Professor Jeff Gordon sent along some thoughts on the Elon Musk's fight with Twitter and gave me permission to post them as a guest post:

I've been thinking about settlement possibilities.  It's now a kind of baseball arbitration, with choices between $1 BB and $44 BB.  As to settlement: I think the problem is going to be whether the Board can get out of what might be called the Revlon "box."  The $$ payout necessary to make Twitter whole in a financial sense is very large, $20 billion?  I haven't done the math.  It's this odd circumstance where the Board could have refused to sell to Musk on the grounds of some "public" value to Twitter ex Musk (perhaps with some dubious claim about maximizing long term value) but Revlon narrowly applied seems to say they (ie, board in fulfilling its fiduciary duty) can't do a "nevermind" to unwind a friendly sale to restore status quo ante.  

 

[$54/sh - standalone value (less than $37/sh which includes chance that deal goes through at a price higher than $37] x # shares outstanding.]  

 

I see that Ch McCormick is the judge.  Bad news for Musk, I think, since she is unlikely to go off on some doctrinal fancy.  The straight down the middle analysis favors Twitter.

 

A further thought:  I think the key to  specific performance will in the end be the financing conditions.  If I were a merger arb I will be looking very closely at those agreements.  If the banks have a legit basis to walk, then I think we are in the realm of Alliance Data Systems Corp v. Blackstone Capital Partners, in which parties are held to the terms of their deal structure.  

Guest Post: Russell Powell responds to my comments on his new paper Spirit of the Corporation

I am delighted that Russell Powell offered a guest post responding to my recent comments on his paper Spirit of the Corporation. His comments follow:

Thanks to Professor Bainbridge for taking an interest in and recommending my article “Spirit of the Corporation,” which was presented at the recent Berle Symposium (this year focused on religion and corporate law). His question, whether considering spirit as opposed to corporate culture does any significant work, is one that was raised at the symposium, and I acknowledge that the ideas are overlapping. I do not object to readers choosing to consider my formulation of corporate spirit a variation of corporate culture discourse. That said, in this work I am attempting to seriously engage theological traditions in their own contexts (Catholicism and broader Christianity, in particular). In my symposium presentation, I explained that I was attempting to use Rawlsian method regarding public discourse by presenting my private, religiously-based reasons along with parallel, secular reasons. Professor David Skeel appeared to take a similar approach with his very interesting paper “The Corporation as Trinity.”

I am comfortable with the range of definitions for spirit in the paper, but I do not focus on corporate culture explicitly. There is obviously a rich and diverse body of literature on corporate culture from a variety of fields over the past fifty years. Many of those descriptive and normative approaches would be consistent with my characterization of corporate spirit. However, I would argue that there are distinctions, even from a purely secular perspective. Definitionally, I am uncomfortable completely conflating spirit with culture. Is the spirit of the law (its essence or ideal) completely synonymous with legal culture or the culture of law? I think of corporate culture as the granular social facts that shape the tacit values, customs, traditions, and meanings within a particular business organization. In much of the business literature, there is an emphasis on internal mechanisms, policies and incentives, while legal scholars tend to emphasize the role of external rules. Corporate spirit might be considered a broader, inclusive category which focuses on the orientation of the entity toward particular goods, rather than the myriad mechanisms that contribute to that orientation. Although changing internal structures and external incentives can impact corporate culture, I wonder whether religious traditions that emphasize the need for internal transformation may contribute a helpful insight regarding the necessity for internal transformation as an important predicate for institutional reform.

Like Professor Bainbridge, I do not attribute to corporations a soul. From a Christian scriptural perspective, the soul may be distinguished from the spirit (e.g., I Thessalonians 5:23 and Hebrews 4:12). Though undoubtedly an oversimplification, I would argue from a Christian perspective that soul consists of mind, emotions, and will (aspects not easily attributable to institutions), while spirit reflects a person’s orientation toward the divine (or more generally, the good). Scholars of structural sin might identify a “spirit of violence” or a “spirit of joy” within a human institution. However, even in a Christian theological context, this does not mean that separate ethereal entities are created by human-institutional interactions, and that is not my contention. Furthermore, I am not arguing that there is something eternal about the spirit of Nike or McDonalds. Corporations wind up, sell their assets, are purchased or merged in ways that dissolve the entity or radically transform internal culture as well as their essential orientation toward particular goods. Think, for example, of the purchase of Whole Foods by Amazon and the macro and micro changes in management that followed.

My paper is not meant as an endorsement of any specific contemporary approach to corporate decisionmaking or purpose (though I note several); instead, it is primarily a reflection on Berle’s essay “Corporate Capitalism and the City of God,” wrestling with the question whether corporate managers ought to consider the common good along with or as part of their obligation to act in the best interests of the corporation. To that end, I wanted to bring theological perspectives to the discourse, and I am heartened that the piece has generated some fruitful cross-discipline interest and dialogue.

Guest Post: Does Van Gorkom's requirement of an informed decision survive Corwin?

My friend Robert T Miller of the University of Iowa law school sent along this email in response to my post Does Van Gorkom's requirement of an informed decision survive Corwin? I'm stumped:

I stand by my conclusion in the article on Van Gorkom. I get there primarily because I don’t read Stroud as expansively as you do. In addition, I’m not completely clear what meaning you’re attributing to Singh, but as I read it, there’s nothing in Singh that contradicts what I said in the article. And, to be clear, my article does not predate Singh. Singh was decided in 2016, and I wrote the Van Gorkom article in 2017. I cite Singh twice in the article, in nn. 631 and 676.

To start with Stroud, I read the case to mean that, in fulfilling its duty of candor, a board need not draw legal conclusions such, “We breached our duty of care.” Nevertheless, to fulfill its duty of candor, it must disclose all the material facts in its possession, including any facts that tend to show that it breached its duty of care. That is, the board does not need to say, “We were grossly negligent,” even if it actually believes that. But the board does need to say (provided this is true), “We met for one hour to discuss the merger, but we spent most of the time talking about baseball.” I believe the rule here is same as it is under the federal securities laws.

As to Singh, I read it as merely correcting VC Parson’s misunderstanding of Corwin in the opinion below, which is In re Zales Corp. Stockholders Litig., 2015 WL 6551418 (Del. Ch. 2015). That is, in Corwin, the Supreme Court talked about “the business judgment rule” applying after an uncoerced, fully-informed shareholder vote (compare how the court talked in Unocal).Such language, however, is ambiguous. On one reading, it means this: in a Revlon transaction, after an effective Corwin vote, the standard of review shifts from Revlon to the BJR, in the sense that the court will review the board’s actions from the beginning asking not whether the board took reasonable steps to get the best price reasonably available but whether the board breached its duty of loyalty or its Van Gorkom duty of care. On another reading, the language in Corwin means this: in a merger that would be reviewed under either Revlon or the BJR, after an effective Corwin vote, the standard of review shifts to the rational business purpose test, the standard of review that applies when the BJR is satisfied (i.e., there has been no breach of the board’s duties of loyalty or care). In the opinion below, the Court of Chancery had read Corwin the first way at the re-argument phrase. What Strine is saying in Singh is that this reading is a mistake. It is the second interpretation of Corwin that is correct: after an effective Corwin vote, the suit should be dismissed unless the merger lacks a rational business purpose (i.e., amounts to waste).

To turn to your problem, then, my answer is the following. The board’s duty of candor requires that it state all material facts in its possession in the proxy but not that it state legal conclusions such as, “We breached our duty of care.” If the board really was grossly negligent in approving the merger, then the board must state the material facts, which will support the conclusion that it breached its duty of care. If the board fulfills this duty and the shareholders vote to approve the merger anyway, then the vote will be effective under Corwin. Hence, the cause of action for breach of the duty of care will be extinguished, and the only possible claim is for waste. That claim will fail, and the suit will be dismissed.

If the board fails to state all the material facts about its process, however, then the Corwin vote will not be effective. As a result, the shareholders may sue for any breach the board committed, including a breach of the duty of care. Nevertheless, if the corporation has a 102(b)(7) charter provision, any claim sounding in the duty of care will be immediately dismissible under Malpiede v. Townsend. In the extremely unlikely event that the corporation does not have a 102(b)(7) provision, however, the shareholder’s suit will go forward, and the directors will be liable in damages for their breach of the duty of care. This is the same conclusion I reached in the Van Gorkom article.

We are disagreeing here, I think, primarily because of our disagreement about Stroud. If I follow you, you’re reading Stroud as meaning that a board’s duty of candor does not include stating material facts in its possession that tend to show it breached its fiduciary duties. If it were right, then a board could breach its duty of care, not disclose the material facts about the breach in the proxy, get an effective Corwin vote on the basis of that proxy, and then use that Corwin vote to extinguish the claim based on its duty of care. In my view, that would be an outrageous result, and, as I say, I don’t think that’s the law. I note too that your example concerns breaches of the duty of care related to the approval of the merger. Part of what I’m talking about in the passage you quote concerns breaches of the duty of candor—i.e., it goes to why the proxy omitted to state material facts. Such omissions can arise either from breaches of the duty of loyalty or from the duty of care. Those questions get more complicated, but, as I saw, I understand your example as applying to the simpler issue of a breach of the duty of care in the approval process of the merger.

That was very helpful.

Guest Post by JW Verrett: Forensic Accounting, Corporate Law, The CIA, & The Hunt for Aldrich Ames

J.W. Verret here.

I have recently embarked on a career shift to focus study on accounting, specifically forensic accounting, and how it relates to the core issues in corporate, securities and banking law that have previously been the focus of my scholarship.  That has included getting certified as a CPA and as a CFF (certification in financial forensics).

Along the way I’ve learned a ton about using financial accounting and forensic accounting techniques to catch bad guys.  Forensic accounting is a core tool for financial fraud investigations under the securities laws (10b-5, FCPA, etc.) and banking law.  It is also a core tool used by Delaware companies to meet their Caremark oversight obligations as forensic accountants design internal controls to prevent compliance violations and utilize forensic accounting to catch violators. 

Before digging into issues at the intersection of forensic accounting and corp/securities law, I thought I would introduce readers to forensic accounting through the story of the FBI and CIA’s efforts to catch Aldrich Ames.  This spy hunt was only successful because of evidence put together by a forensic accounting team conducting a net worth analysis, a common tool of forensic accountants which shows that changes in a subject’s net worth cannot be sufficiently explained by their legitimate sources of income.

Aldrich Ames sold information to the KGB about the identity of our intelligence assets within the USSR, and at the time of his arrest he was responsible for the greatest intelligence leak in American history.  He identified at least ten active agents for the US, some of whom were later executed by the Soviets as a result of his tips.

A classic tool used by forensic accountants to guide investigations is the “Fraud Triangle.”  Three factors that are nearly universal in frauds studied in an early survey of embezzlers by criminologist Donald Kressey.  Its components are pressure, opportunity, and rationalization.  In Ames’s case, pressure for money came initially from an expensive divorce and then from a lavish spending lifestyle he shared with a new wife (when she was arrested, investigators found 60 purses and 500 pairs of shoes among other items). 

Opportunity (a prong that usually reflects poorly on the organization) was here created by his ability to walk out of headquarters with armloads of documents to give the Soviets (since remedied by the agency).  Opportunity also came a result of his legitimate cover for meeting with handlers, which was often that he was attempting to recruit them in reports he would file with the agency about the meetings. 

Rationalization in his case was a personal grudge over being passed over for promotion because of the impact of his drinking on his work.  He would frequently return from long lunches unable to function.

The Fraud Triangle doesn’t only help to explain an embezzler, financial fraud, or in this case spy’s behavior after being caught.  It informs key aspects of an internal investigation, from the email keywords used in email searches to the questions asked during internal interviews as a fraud investigator attempts to track down the perpetrator.

The fascinating details of the investigation of Aldrich Ames can be found in a Senate Intelligence Committee Report, available here.

The first 40 pages outline an intelligence disaster, a ten-year period during which Ames lived a dangerous double life.  Some of his methods utilized sophisticated tradecraft, code names and the famous “dead-drop” mailbox where he would leave markings to indicate he left intelligence in one of several KGB dead drop locations for pickup.

Near the end of the story, the FBI and the CIA know they have a mole on their hands and have seen entire intelligence networks overseas rolled up by the KGB (and later the FSB) overnight.  The first break they have in the case is a tip that Ames cover for his excessive spending, that he inherited the money from his wife and her family, was bogus.  Subsequent forensic analysis of his spending showed him spending cash amounts of nearly $1.4 million and credit card billings of another $500,000 between 1985 and 1993.  During that 8 year time-frame his aggregate CIA take home pay was $336,000.

Ames covered his tracks in part through the classic money laundering techniques of placement, layering, and integration.  Placement takes illicit cash and enters it into the financial system.  He would make structured cash deposits just below the SARs reporting threshold at which banks must report them to the Treasury Department of $10,000.  He would then move the money overseas between various accounts, and then wire it back to the US to make it appear that the money came from his wife’s family.

One challenge CIA officials faced in investigating Ames was that, despite their tips concerning his strangely lavish spending, they did not have the authority themselves to obtain information from banks where he may have done business.  And, at least early in the investigation, the CIA wasn’t eager to expose their dirty laundry to the FBI to pursue a FISA warrant.

From the initial tip about Ames’ odd spending, until his arrest, Ames was able to continue giving away secrets for four years!  At one point a CIA officer went to Bogota to determine whether Ames’ wife was the source of his money.  His was able to vaguely confirm that her family was successful, and had donated to a local sports stadium for naming rights, but specific details like Ames’ assertion about a windfall of money from his mother-in-law’s insurance policy were never nailed down.

It took some time for the FBI to gain access to his bank accounts to review the cash transactions.  Once they did, the investigation quickly focused on him.  One piece of smoking gun evidence in the case was the fact that roughly $9,000 cash deposits, in amounts at multiple banks appearing to be structuring transactions designed to stay below the suspicious activity reporting (SARs) threshold, seemed to take place just after incidents in which Ames was documented meeting with Soviet officials.  Some of those meetings were documented by Ames as his efforts to “recruit” potential agents who were in fact his handlers.  Some of those meetings were documented by FBI agents tailing the Soviet officials (who recorded Ames’ meeting with them) but suspiciously not documented by Ames in violation of procedure.

Spy stories are fun.  Similar fact patterns play out in corporate internal investigations every day as corporations seek to maintain compliance with the federal securities and banking laws and fulfill their oversight duties under Caremark.  The Fraud Triangle and other techniques of forensic accounting utilized in the mole hunt for Aldrich Ames are also used to design internal controls and to conduct investigations of suspected fraud in corporations.  As a fan of cold war era spy fiction (I’ve probably read Le Carre’s George Smiley series a half dozen times) I think that is pretty cool.

Please welcome J.W. Verret to PofessorBainbridge.com as occasional guest poster

From time to time, the PB.com editorial board opens the blog to distinguished colleagues who offer guests posts on areas in which they are working that overlap with the interests of the blog. (If you're interested in guest posting, let us know. But remember many will apply but few will be chosen.)

We're delighted that GMU Law Professor J.W. Verret is our newest guest poster. Jay teaches Banking, Securities, Corporation Law, and Accounting for Lawyers.

He serves on the Investor Advisory Committee of the Securities and Exchange Commission, where he advises the Chairman of the SEC on legal and policy reform.  He is faculty liaison to the American College of Business Court Judges. He also serves as Independent Chairman of the Board of Directors of Egan-Jones Ratings, one of the eight domestic credit rating firms licensed by the SEC to provide credit ratings on the debt of public companies and provides recommendations on shareholder proxy votes.

He has served as Chief Economist and Senior Counsel to the U.S. House Committee on Financial Services.  He previously clerked on the Delaware Court of Chancery.  He received his JD from Harvard Law School, a Masters in Public Policy from the Harvard Kennedy School, and a BS in Financial Accounting from LSU.

His work as appeared in venues from the Stanford Law Review and the Journal of Law and Economics to the Wall Street Journal and New York Times.  He has appeared on most major television networks on financial regulatory issues and has testified before the U.S. House and Senate over a dozen times.

Be sure to check out his SSRN page.

We've cited his work many times here at PB.com, as far back as 2009. We're excited to have him contribute.

A perfect storm of the BRT, SEC, ESG, and GAAP

J.W. Verret here, honored to join for a few guest posts.  When I was young once and on the market, Prof. B blogged my work even when he didn't agree with it. You never forget that. I've been on weird scholarly hiatus the last couple of years to bulk up my accounting toolkit with the CPA exam (done!) and some time as Chief Economist at the House Fin. Services Committee. If you can forgive it, you will see some financial accounting policy and DC beltway stuff mixed in with corporate governance and securities law during my visit here.

 

Prof. B has posted about the Business Roundtable Statement on Business Purpose, and I agree with his assessment of their true purpose. Bebchuk recently pointed out some of the problems with stakeholder capitalism generally and the Business Roundtable statement specifically here.

 

I sit on the Securities and Exchange Commission's Investor Advisory Committee, where we have spent the year partly playing out a related debate regarding a series of recommendations that were approved by the IAC over substantial and vigorous dissent.

 

The question we faced there was somewhat different from the question of proper corporate purpose. Does ESG based disclosure, disclosure which is one tool to encourage stakeholder based governance, fit into the mandatory disclosure architecture of the federal securities laws and related GAAP accounting policy?

 

And yet it isn't really a different question. The entire goal behind ESG disclosure is to shame CEOs into supporting politically charged initiatives regarding environmental or social policy that are embraced by stakeholder governance theory. The question for that purpose is not whether it would be a good thing (and I don't concede it would), but instead does it fit within the federal securities laws and longstanding GAAP accounting policies?

 

Our first debate was over a recommendation that the SEC include more information about human capital metrics in the Management Discussion and Analysis section of the annual report, see here. There was a focus in the recommendation on variables like relative mix of part-time vs full-time worker. It was of the same vein as the pay ratio rules in Dodd-Frank, if a smidge less obvious in its pro-labor advocacy.

 

I argued vigorously against mandatory non-financial human capital disclosure in a dissent here.

 

What's wrong with more human capital disclosure, you ask? I don't believe the SEC has the legal authority to mandate it if it fails to meet the materiality definition in the federal securities laws. And these disclosures (while no doubt material to a subset of labor union pension funds for their own personal reasons) would not have a material impact on shareholder wealth. 

 

This was the same argument I've made previously against mandatory disclosure of corporate political spending, see here.  If a future SEC requires such disclosure a legal challenge would likely succeed because the disclosure is not material. A recent debate over a broader ESG mandate recommendation by the SEC IAC played out along similar lines, see here.

 

My other concern about mandatory ESG based disclosure rules is that they would muck up Generally Accepted Accounting Principles (GAAP) with items in the narrative of the annual report that are inconsistent with the financial accounting estimates. 

 

GAAP isn't perfect. The one way we are certain to make it worse is to allow politicians to infect financial accounting with political objectives. Mandatory ESG disclosure rules from the SEC is one way left leaning politicians have been pressuring the SEC to do just that.

 

There is no shortage of ESG disclosure guidance and standard setting bodies out there, including the Sustainability Accounting Standards Board. There are investment funds dedicated to ESG investing that can use those metrics. If investors want to support those initiatives with their own cash, then best wishes. 

 

Meanwhile, let's not allow the ESG crowd to overextend the SEC beyond the reach of its jurisdiction or muck up GAAP with socio-political and cultural objectives.

Guest post by Bryce Tingle on teaching remotely

Our latest guest blogger is Bryce Tingle, N. Murray Edwards Chair in Business Law Director Financial Markets Regulation Programme, School of Public Policy Faculty of Law, University of Calgary.

I have a tremendously creative brother who manages the communications of the vast provincial health authority — most of the advice has come from him.

 

My experience with teaching online is very similar to yours.  I had an engaged, motivated class of students in Corporate Finance for the first two months and then after we moved online, they became passive and disinclined to participate. I have personally long believed that the single most boring cultural artifact we have developed as a civilization is the webinar, so it was with chagrin that I eventually realized webinars is what I was offering the students.  

 

Based on my experience this spring, I am recording my lectures for the fall and letting students listen to them asynchronously.  Each of the recorded lectures is no more than 15 minutes — which has meant splitting each week's lectures into smaller parts.  If I can’t stand to watch a lecture that’s longer than 15 minutes at a go, I can’t imagine my students will manage it.

 

At my brother’s recommendation, I used my iPhone to record videos of me lecturing.  (My brother advises that when the subject is sitting still, even iPhones that are several years old shoot video that is indistinguishable from high-end cameras.  He did recommend that I get a high-quality microphone to plug into the phone, as the sound on cell phone videos is poor.)

 

I found the usual things when I reviewed the first few lectures: I say “umm” and pause way too much; I don’t think my head presents a compelling object to stare at for hours on end; and it is boring to watch any person engage in a monologue.  Consequently, I have adopted the following plan:

 

1. I use the voice app of the iPhone to record my lectures (no video);

 

2. I send the sound file of each lecture to my RA this summer (we were provided with student help to move our courses online — and to ameliorate a terrible labour market for summer jobs).  The first thing he does is extensively edit the sound file to remove “umms”, pregnant pauses, sentences that end so poorly they must be redone, etc.

 

3. He then uses vyond.com to animate the videos.  My brother recommended Vyond as the simplest animation software to use.  Based on my experience so far, the animated videos — likely because they involve movement and change — are much easier to watch than a talking head.  I should note that my RA has no experience in computer graphics and had never used Vyond before.  He picked it up quite quickly.

 

4. These videos will be posted on a password-protected website (created and hosted on Squarespace in less than a day).

 

5. I will likely only spend an hour each week with the students synchronously on Zoom.  The in-person class will allow them to ask questions, we will work through problems together (which is part of how I normally teach), and I will have them take a quiz on the readings each class.  I am not going to record the classes for both privacy reasons and because I think that encourages students to skip class with the dubious plan of watching the recording later.  

 

6. I am concerned that the strong tendency of even good students this fall will be to let things slide.  What I saw this spring is that students have difficulty motivating themselves when they are at home all day.  This is why I am introducing a weekly quiz on the readings.  Their over-all performance on the quizzes over the semester will be worth something like 20% of their final grade.  I want to give them an incentive to stay current on the readings and to attend our synchronous online classes.  I am using Tophat to administer the quizzes.

 

7. In my Entrepreneurial Law class, I usually have each student do a paper on a startup of their choice (drawn either from a list of books or one they have encountered in real life).  This year, I am going to have each of them do up a 10 minute presentation and randomly select one or two each week to give their presentation over Zoom.  I think it will be helpful for students to be engaged if I am not the only one talking.

Was Paul Koppell a good agent but bad citizen? Guest Post from McDonnell and Hill

I recently read a really interesting paper by Brett McDonnell, Claire Hill, and Aaron Stentz. It struck a particular cord because I had just watched a rerun of the Law & Order episode House Counsel, in which the great Ron Liebman plays a mob lawyer who crosses the line from zealous representation to participation. I queried Brett about whether their paper spoke to the episode and, in light of that discussion, I invited Brett and Claire to do a guest post about their article. It follows:

Professor Bainbridge has very kindly asked us to post about our new article, Bad Agent, Good Citizen? Law and economics have related but distinct concepts of “agent.”  In economics, when someone acts as an agent, she must act for the benefit of her principal, not for her own or another’s benefit.  In law, this is also so – except that there is an override when an agent is acting for the benefit of her principal, but is helping the principal break the law. For instance, a law-breaking board breaches its fiduciary duties to the corporation even where the law-breaking benefited the corporation.  

But what about cases where action may help the principal but hurt society without breaking the law? Our paper considers four possible cases: good agent/good citizen, good agent/bad citizen, bad agent/good citizen and bad agent/bad citizen.  The first and the last are not that interesting analytically.

Our interest lies in the other two categories. The good agent/bad citizen lawyer might help Greece design financial instruments that would conceal the extent of its debt. The bad agent/good citizen might exaggerate possible perils to the client of environmental non-compliance in order to get the client to comply more maximally as per the lawyer’s own preferences. 

In the less interesting cases, we know where we stand, both from a legal point of view, and from an economics point of view.  The mixed cases are murkier, with law introducing a tension, and another party in interest, into the agency relationship—something we conclude we favor, and suggest ways to promote. That is, legal ethics should leave some (though limited) space for lawyers to act as better citizens at the cost of being less good agents.

While the context for our paper was a symposium on corporate law, Professor Bainbridge asked us how it applies to criminal law, drawing our attention to an episode of Law and Order, House Counsel.  The lawyer aggressively uses procedural devices to shield his crime boss client from being held criminally liable.   Eventually, the DA is able to counter those devices, and indeed, obtain a conviction of the lawyer himself, who has crossed the line and participated in heinous crimes in furtherance of his client’s crimes. At that point, the lawyer was clearly a bad citizen, but also a bad agent in the legal sense, since legal ethics forbids helping clients break the law. (The lawyer was, though, a good agent in the economic sense.)

But what of a typical representation, where a lawyer defends a crime boss against allegations based on the client’s (past) behavior? We will assume, to make it a harder case than the one in House Counsel, that a lawyer suspects the client may be guilty but does not have direct knowledge of the client’s guilt. What makes such a lawyer not a bad citizen when the law is working as intended is that he is opposed by an equally aggressive advocate on the other side.  Of course, in the real world, the law often does not work as intended.  Prosecutors will often do better than law intends them to: Poor defendants will not have advocates whose aggressive advocacy equals that of the prosecutor, and hence are at a disadvantage.  And they may do worse than law intends them to, insofar as (well-resourced) defendants may be able to take advantage of certain structural features designed to ‘let a thousand guilty men go free to avoid convicting an innocent one.’ Thus the problem remains: criminal defense lawyers should zealously advocate for their clients, consistent with law's imposition of various ‘good citizenship’ requirements on lawyers, who, after all, are ‘officers of the court.’  So, our bottom line is perhaps to duck the question of whether aggressive use of procedural devices to get someone who is probably guilty off the hook makes the ‘good agent’ a bad citizen.  

Fiduciary Government

Sung Hui Kim, my friend and UCLAW Colleague writes:

Is the state a fiduciary?  For a growing number of scholars, the answer is yes. In fact, the idea that the state is a fiduciary to its citizens has a long pedigree – ultimately reaching back to the ancient Greeks, and including Hobbes and Locke among its proponents.  Public fiduciary theory is now experiencing a resurgence, with applications that range from international law, to insider trading by members of Congress, to election law and gerrymandering.  A new edited volume of essays, “Fiduciary Government” (Cambridge University Press 2018, 342 pages, $145)explores the implications of the notion that the state is a fiduciary and develops new acounts of how fiduciary principles apply to representation; to officials and judges; to problems of legitimacy and political obligation; to positive rights; to the state itself; and to the history of ideas. The resulting volume should be of great interest to political theorists and public law scholars, to private fiduciary law scholars, and to students seeking an introduction to this new and increasingly relevant area of study. This volume should also be of interest to skeptics of the notion of fiduciary government, as it presents important critiques of fiduciary political theory. 

Review the Title Page, Table of Contents, List of Contributors and Introduction here: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3292645